In December 1996, Alan Greenspan used the phrases “irrational exuberance” to explain the inventory market on the time, and people phrases not solely grew to become the title of Robert Shiller’s cautionary guide on market bubbles, but in addition the beginnings of the assumption that central bankers had the knowledge to be market timers and the ability to bend the economic system to their views. I believe that Greenspan’s phrases appear prophetic, solely with the good thing about hindsight, and I imagine that central bankers have neither the ability nor the instruments to maneuver the economic system in important methods. I used to be reminded of that episode after I learn that Jerome Powell, the present Fed chair, had described the market as “pretty extremely valued”. In market technique converse, these are phrases which are at struggle with one another, since markets can both be “pretty valued” or “extremely valued”, however not each, however I do not blame Powell for being evasive. For a lot of this yr, and particularly since April, the query that market observers and buyers have confronted is whether or not shares, particularly in the US, are pushing into “bubble” territory and headed for a correction. As somebody who buys into the notion that market timing is the unattainable dream, it’s possible you’ll discover it shocking that I believe that Powell is proper in his evaluation that shares are richly priced, however that stated, I’ll attempt to clarify why making the leap into concluding that shares are in a bubble, and appearing on that conclusion are rather more tough to do.
Monetary Markets in 2025
It has, to place it mildly, been an attention-grabbing yr for shares, as financial headwinds and shocks have mounted, with tariffs, wars and politics all including to the combination. After a primary quarter, the place it seemed like monetary markets would succumb to the stress of unhealthy information, inventory markets have come roaring again, shocking market consultants and economists. As a precursor to answering the query of whether or not shares are “pretty extremely valued” right now, let’s check out how we received to the place we’re on September 30, 2025.
Resilient Equities
We are going to begin with US equities, and whereas that will appear parochial, it’s price remembering that they represented greater than 50% of the entire market capitalization of all traded shares on the planet at first of 2025. Within the determine beneath, we take a look at the S&P 500 and the NASDAQ, with the previous standing in as a tough proxy for giant US market cap shares and the latter for know-how firms:
As you’ll be able to see, US equities had been down within the first quarter, however the standardized values point out that it was a lot worse for know-how firms than for the remainder of the market, with the NASDAQ down 21.3% by way of April 8, the market backside, whereas the S&P 500 was down 14.3%. On April 8, the consensus knowledge was that the long-awaited correction was upon us, and that tech shares would take extra of a beating over the remainder of the yr. The market, in fact, determined to upend expectations, as tech got here roaring again within the second and third quarters, carrying the market with it. In reality, by way of the primary three quarters, the NASDAQ has reclaimed the lead, up 17.3% up to now this yr, whereas the S&P 500 is up 13.7%.
We take a better and extra detailed take a look at all publicly traded US equities, within the desk beneath, the place we escape the year-to-date efficiency, by sector:
The 2 greatest performing sectors within the first three quarters of 2025 have been know-how (up $3.93 trillion and 22.4% YTD) and communication companies (up $1.29 trillion and 22.3% YTD). There are 5 sectors which lagged the market, with client staples and well being care successfully flat for the yr, and power client discretionary and actual property up solely 4-6% for the yr. Monetary, industrials and supplies, for probably the most half, matched the general market when it comes to proportion change, and the general worth of US equities elevated by $8.3 trillion (13.76%) within the first 9 months of 2025. When you puzzled by the outperformance of communication companies, it’s price noting that Alphabet and Meta, each of which derive massive parts of their revenues from internet advertising, are categorized by S&P as communication service firms. These two firms are a part of the Magazine Seven. and the businesses on this grouping have been the engine driving US equities for a lot of the final decade, main to speak of a top-heavy market. To evaluate their contribution to market efficiency, we checked out the combination market cap of the seven firms, relative to all 5748 traded US equities in 2023, 2024 and 2025 (YTD):
The mixture market capitalization of the Magazine Seven, as a % of market cap of all traded US firms, has risen from 17.5% on the finish of 2022 to 24.6% on the finish of 2023 to 29.3% on the finish of 2024. Focusing simply on 2025, the Magazine Seven took a step again within the first quarter, dropping to 26.3% of general market cap on March 31, 2025, however has made a decisive comeback since, with a rise in market cap of $2.8 trillion within the first 9 months of 2025, accounting for 52.4% of the general improve in market capitalization this yr. In reality, the Magazine Seven now command 30.35% of the entire market capitalization for US equities, the next % than at first of the yr. During the last three years, the Magazine Seven alone have accounted for greater than half of the rise in market capitalization of all US equities, annually.
There are different dimensions on which you’ll slice and cube US equities, and we did a fast run by way of a few of them, by breaking US firms into groupings, based mostly upon traits, and inspecting efficiency in every one:
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Small cap versus Giant cap: For a lot of the massive century, small cap shares (particularly these within the backside decile of market capitalization) delivered greater returns than massive cap shares. As I argued in a submit from a decade in the past, the small cap premium has not simply disappeared because the Nineteen Eighties, however been changed with a big cap premium. returns in 2025, damaged down by market capitalization at first of the yr, here’s what we see:
As you’ll be able to see, this has been a very good yr for small cap shares, with the underside half of the market seeing a a lot greater improve, in % phrases, in market cap than the highest half of the market, with a lot of the outperformance coming within the third quarter.
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Worth versus development: One other enduring discovering from the final century is that low worth to guide shares delivered greater returns, after adjusting for danger, than excessive worth to guide shares. Whereas that is usually categorized as a worth impact, it really works provided that you settle for worth to guide as a proxy for worth, however even that impact has largely been absent on this century. Breaking down shares based mostly upon worth to guide ratios at first of 2025, here’s what we get:
Whereas it’s too early to rejoice the return of worth, in 2025, low worth to guide shares have finished higher than excessive worth to guide shares, however all the outperformance got here within the first quarter of the yr.
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Momentum: Momentum has been a stronger power in markets than both market cap or worth, and in contrast to these two, momentum has not simply maintained its edge, however strengthened it over the previous few years. Utilizing the worth change in 2024 as a proxy for momentum, we broke firms down into deciles and checked out returns in 2025:
After lagging within the first quarter, momentum shares have made a comeback, with the highest half of momentum shares now main the underside half for the yr to this point in % change in market capitalization.
In sum, it has been a very good yr, up to now, for US equities, however the features have been inconsistently distributed throughout the market, and whereas the primary quarter represented a break from the momentum and tech pushed market of 2023 and 2024, the second and third quarters noticed a return of these forces.
Directionless Treasuries
Whereas rates of interest are at all times a driver of inventory costs, they’ve performed much less of a job in driving fairness markets in 2025 than in prior years. To see why, check out US treasury charges, throughout maturities, in 2025:
Charges have for probably the most half are near the place they had been at first of the yr, with little or no intra-year volatility however financial tales about inflation and actual development suggesting greater strikes. The battle between the Trump administration and the Federal Reserve has obtained an excessive amount of press consideration, however the Fed’s inaction for a lot of the yr and decreasing of the Fed Funds fee in September appear to have had little or no impression on treasury charges.
On Might 16, 2025, Moody’s lowered the rankings for the US from Aaa to Aa1, becoming a member of Fitch and S&P, however once more the impact on treasury charges was transient. If you’re questioning why this didn’t translate into a rise in default spreads (and charges), the probably reply is that markets weren’t stunned by the downgrade, and the most effective proof for that is within the 5-year US sovereign CDS unfold, a market-set quantity for default danger (spreads):
As you’ll be able to see there was a spike within the US sovereign CDS unfold this yr, however it occurred in response to liberation day on March 31, when President Trump introduced punishing tariffs on the remainder of the world. The Moody’s downgrade had little impression on the unfold, and even the tariff impact had absolutely pale by September 30, 2025, with spreads again to the place they had been at first of the yr (and for a lot of the previous few years).
Extending the evaluation of default spreads to the company market, there was comparatively little motion in company default spreads in 2025:
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| Supply: FRED |
As you’ll be able to see, probably the most hanging a part of the story is that so little has modified over the course of 2025, however the spike in spreads within the first week of April, when the tariffs had been introduced. The Moody’s score and the discuss of a recession appear to have finished little to supercharge the worry issue, and by extension the spreads. In reality, the one score that has seen a big transfer is within the CCC and beneath grouping, the place spreads are actually greater than they had been at first of the yr, however nonetheless a lot decrease than they had been on the finish of the primary quarter of 2025.
The Remainder of the Story
The financial shocks that hit the US markets, and which US equities and debt shrugged off, for probably the most half, additionally reverberated in the remainder of the world. The broadest measure of relative efficiency between US and world equities is the divergence between the S&P 500, a proxy for US fairness efficiency, and the MSCI World index, a stand-in for giant cap worldwide shares, and the outcomes are beneath:
Within the first 9 months of 2025, the MSCI world fairness index is up 16.6%, about 2.3% greater than the S&P 500 over the identical interval. Nevertheless, all of this underperformance occurred within the first quarter of 2025, and the S&P 500 has discovered its profitable methods once more within the second and third quarters.
The MSCI index does obscure variations throughout areas and is titled in direction of massive cap shares. Consequently, we checked out all publicly traded equities, damaged down by areas, with the values in US {dollars}, and the outcomes up to now in 2025 are within the desk beneath:
World equities had been up, in combination greenback market capitalization, by 16.8%, and whereas US equities have underperformed within the first 9 months of 2025, with a 13,8% return, they’ve rediscovered their mojo within the second and third quarters. The worst performing areas of the world are India, down 3.15%, in US greenback phrases, this yr, and Africa and the Center East, up solely 2.13%. It’s too early to spin tales for why these areas underperformed, however in my knowledge replace submit from the beginning of 2025, I pointed to India as probably the most extremely priced market on the planet, and this yr might replicate a cleansing up. The remainder of the world ran forward of the US, with among the further return coming from a weaker US greenback; the native forex returns in these areas had been decrease than the returns you see within the desk.
US Equities: Overpriced or Underpriced?
Not one of the dialogue above solutions the query that we began this submit with, which is whether or not US equities are overpriced. To make that evaluation, there are a selection of metrics which are used, and whereas all of them are flawed, they differ when it comes to what they miss of the evaluation, and the assumptions that underlie them.
At one finish of the spectrum, the only and most incomplete metric is predicated purely on worth historical past, with markets which have had prolonged good runs being considered as overpriced. A modification is to carry earnings into the evaluation, with costs transferring disproportionately greater than earnings (leading to greater or decrease PE ratios) thought-about a sign of market mispricing. The third adaptation permits for the returns you may make on different investments, within the type of rates of interest on treasuries, to make a judgment on market pricing. The ultimate and fullest variant considers development within the evaluation, bringing in each its good aspect (that it will increase earnings in future intervals) and its unhealthy aspect (that it wants a portion of earnings to be reinvested), to make a pricing judgment, however even that variant ignores disruptions that alter market dynamics and danger taking.
1. Rising inventory costs
For some buyers, an prolonged stretch of rising inventory costs is, by itself, ample purpose to conclude that if shares are doing so effectively, they should be overestimated. This concern will get deeper because the market run will get longer (when it comes to time) and steeper (when it comes to worth rise). Utilizing that framework, you’ll be able to see why discuss of a inventory market bubble has constructed up during the last decade, as shares preserve climbing partitions of fear and hitting new highs. We have had a outstanding bull run in US equities during the last 15 years, with the S&P 500 up over 500% over that interval:
In brief, the annual return (18.74%) that fairness buyers have earned during the last fifteen years is considerably greater than the annual return (9.94%) on US equities during the last century. For some, this run-up alone is sufficient to resolve that equities are overpriced and incomplete although this evaluation is, you’ll be able to see its draw for a lot of buyers.
2. The Earnings Impact
rising inventory costs as an indicator of overpricing ignores the truth that markets can generally be up strongly, not due to hypothesis or over pricing, however due to rising earnings. That’s the reason that many buyers take a look at market pricing scaled to earnings, or PE ratios, and the graph beneath captures three variants of the PE ratio – the trailing PE, the place you scale market pricing to earnings within the final twelve months, a normalized PE, the place you scale the market pricing to common earnings over an extended time interval (a decade) and a CAPE or Shiller PE, the place you first modify earnings for inflation after which normalize:
All three variations of the PE ratio inform the identical story, and in September 2025, all three stood near all time highs, with the spike on the peak of the dot com growth being the one exception.
3. The Investing Options
Shares that commerce at greater multiples of earnings are clearly dearer than when then commerce at decrease, however to make a judgment on whether or not they’re overpriced, you continue to have to check them to what you may make on different investments. For buyers in monetary property, these different investments are bonds (in case you are investing long run) or business paper/treasury payments (in case you are investing brief time period). Logically, if these alternate options are yielding low returns, you ought to be prepared to pay a a lot greater multiples of earnings for dangerous property (like shares). A technique during which we are able to carry on this alternative is by flipping the PE ratio (to get the incomes to cost ratio or earnings yield) and evaluating that incomes yield to the ten-year treasury bond fee:
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Between 2011 and 2020, as an illustration, the earnings yield was 5.46% however that was a lot greater than the 10-year treasury bond fee, which averaged 2.15% over that decade. In 2021, the earnings yield dropped to 4.33%, near a historic low, butt with the treasury bond fee at 1.51%, you may argue that fairness buyers had nowhere else to go. As treasury bond charges climbed again in direction of 4% in 2022, inventory costs dropped and the earnings yield climbed to five.72%. Within the final three years (2023-25), treasury charges have stayed greater (4% or extra), however earnings yields have dropped. In reality, the earnings yield of 4% in September 2025 was 0.16% beneath the ten-year treasury bond fee, triggering bearish warnings from analysts who use the distinction between the earnings yield and the ten-year bond fee as their market timing metric.
4. The Remainder of the Story – Money flows, Progress and Threat
The earnings yield, along side the treasury bond fee, is extensively used as a market timing instrument, however it has two, maybe deadly, flaws.
- The primary is that it treats shares as in the event that they had been glorified bonds, treating the earnings yield like a coupon, and misses the explanation that buyers are drawn to equities, which is the potential for development. Incorporating development into the evaluation has two results, with the primary being that you simply want reinvestment to develop, and that reinvestment comes out of earnings, and the second being the upside of accelerating earnings over time.
- The second is that the earnings yield/ treasury bond fee differential has had a spotty report timing the market, lacking a lot of the good bull market of the Nineteen Eighties and Nineties, and clearly not offering a lot predictive energy within the final two years.
There’s an method that you need to use to include the expansion and money movement results into your market evaluation. It’s to estimate an intrinsic worth for the market, the place you incorporate the expansion and reinvestment results into anticipated money flows, and low cost them at a required return that includes what you’ll be able to earn on a riskfree (or near riskfree) funding and a danger premium for investing in equities.
As you’ll be able to see, the intrinsic worth equation can be utilized in one in all two methods to evaluate the market. One is to again out an inner fee of return, i.e., a reduction fee that yields a gift worth equal to the market index; netting out the treasury bond fee from this yields an implied fairness danger premium for the market. The opposite is select an fairness danger premium that you simply imagine is affordable and to worth the market.
As is usually the case with historic comparisons, there’s something right here for each aspect of the talk. For many who imagine that the market is overpriced, the plain comparability is to fairness danger premiums because the 2008 disaster, and the conclusion could be that the Sept 2025 premium of 4.01% is just too low (and inventory costs are too excessive). For many who are extra sanguine in regards to the market, the comparability could be to the dot-com growth days, when the implied fairness danger premium dipped to 2%, to conclude that this market will not be in a bubble.
An alternate strategy to assess market pricing is to imagine an fairness danger premium and estimate the worth of the index utilizing that premium. Thus, if we assume that the typical premium (4.25%) from 1960 to 2024 is a good premium to the market, and revalue the index, here’s what we might get as its worth:
With an implied fairness danger premium of 4.25%, and a riskfree fee of 4.16%, we get an anticipated return on shares of 8.41%, and utilizing analyst estimates of development in earnings and money payout ratios that modify over time to sustainable ranges, we arrive at a worth for the index of about 5940, 12.6% decrease than the index worth on September 30, 2025.
The Market Timing Problem
It’s simple that this market is richly priced on each metric, from PE ratios to the earnings yield, internet of treasuries, to intrinsic worth measures just like the fairness danger premium, thus offering backing for Powell’s evaluation of equities as “pretty extremely valued”. When you belief in imply reversion to historic averages, it appears affordable to conclude that shares are in actual fact overpriced, and due for a correction. On this part, we are going to study why, even if you happen to come to this conclusion, it’s tough to transform it into motion.
Utilizing lawyerly language, let’s stipulate that markets are overpriced right now, although that overpricing can cowl a spread of views from the market being a bubble to the markets simply being costly. There are 5 responses that you may must this judgment, starting from least aggressive to most aggressive in the marketplace timing entrance:
- Do nothing: The essence of being a non-market timer is that you don’t alter any facet of your portfolio to replicate your market views. Thus, in case your most popular allocation combine is 60% in shares and 40% in your bonds, you stick with that blend, and also you not solely maintain on to your present investments however you proceed so as to add to them in the identical method that you’ve at all times finished.
- Maintain on to/ construct money holdings: For probably the most half, you match what you’ll have finished within the do nothing response when it comes to general asset allocation combine and holdings, however you not solely put your portfolio additions into money (treasury payments, cash market funds) however while you act, will probably be extra more likely to be promoting present holdings (that you simply view as over valued) than shopping for new ones. For a lot of fairness mutual fund managers, this statistic (liquid property and money as a % of property beneath administration) is a tough proxy of how bullish or bearish they’re in regards to the general market.
- Change asset allocation combine: On this response, you revisit your most popular asset allocation combine, which was set based mostly in your age, money wants and danger aversion, and alter it to replicate your market timing views. Thus, if you happen to imagine that shares are overpriced, however you view bonds as pretty and even beneath priced, you’ll lower your allocation to the previous, and improve your allocation to the latter. If you’re constrained to be an all-equity investor, an alternate model can be to reallocate your cash from overpriced geographies to underpriced geographies, if the latter exist.
- Purchase safety: With the expansion of choices and futures markets, you now have methods of defending your portfolio, with out making wrenching modifications to your asset allocation or holdings combine. You should buy places on the index or promote index futures, if you happen to assume equities are overpriced, and profit from the truth that the income from these positions will offset the losses in your portfolio, if there’s a correction.
- Make leveraged bets of market correction: Probably the most aggressive strategy to make the most of market timing is to make leveraged bets on market corrections, utilizing both derivatives markets (places or futures) or promoting brief on both all the shares in an index, or a subset of probably the most overpriced.
In making this decisions, you do have to think about three actual world considerations. The primary is taxes, with any methods that requires important disruptions to present portfolios, reminiscent of altering asset allocation mixes or promoting overvalued shares within the portfolio, creating bigger tax payments. The second is transactions prices, which may even be greater for any technique that’s constructed round extra aggressive. The third is timing, which is that even in case you are proper in regards to the overpricing, being proper too early might wipe out the advantages. Talking of Alan Greenspan’s warnings in regards to the dot com bubble, it’s price remembering that his “irrational exuberance” feedback had been made in 1996, and that the market correction occurred in 2001, and any investor who offered equities proper after the feedback had been made would have underperformed an investor who held on to equities and took the hit from the correction.
Let’s assume that you simply take away taxes and transactions prices from the evaluation to present market timing the absolute best pathway to success. To check whether or not market timing works, it’s important to create a market timing technique round your metric of alternative, with three steps fleshed out:
- Select your pricing metric: As famous within the final part, this may be the proportion improve in inventory costs over a latest interval, the present or normalized pricing ratio (PE, PBV, EV to EBITDA) or the fairness danger premium/intrinsic worth for the index.
- Create your motion rule: The motion rule specifies the brink for the chosen metric, the place you’ll act in your market timing. You may, as an illustration, resolve that you’ll improve your fairness publicity if the PE ratio is greater than 25% beneath the median worth for the market’s PE ratios over the earlier 25, 50 or 100 years, and scale back your fairness publicity if the PE ratio is greater than 25% greater than the median worth over the interval. Word that the commerce off on setting the brink is that setting it to a bigger worth (say 50%) will imply that you simply time the market much less.
- Select your market timing response: You specify how a lot you’ll improve or lower your fairness publicity in response to the market timing sign. Thus, when you’ve got base asset allocation mixture of 60% equities, 40% bonds, you’ll be able to resolve that in case your threshold (from step 2) is breached, and the PE ratio drops (will increase) by greater than 25% beneath the median, your fairness publicity will improve (lower) to 80% (40%) and your bond publicity lowered (elevated) to twenty% (60%). The extra aggressive you might be as a market timer, the better would be the shift away out of your base combine. Thus, you may promote all equities (0% equities, 100% bonds) if the market is overpriced and maintain solely equities (100% equities, 0% bonds) if the market is underpriced.
As an instance, let’s use the Shiller PE, choose a 25% threshold for market cheapness and alter your asset allocation combine, which might usually be 60% fairness/40% debt to 80% equities/20% debt if the Shiller PE drops 25% beneath the median (computed over the prior 50 years) and 40% equities/ 60% bonds if it rises 25% above the median.
Word that the check can simply be different, utilizing a distinct metric, completely different thresholds and completely different timing responses.
To keep away from being accused of cherry choosing the info or deviating from the usual measures of the Shiller PE, I downloaded the uncooked knowledge on inventory returns, bonds and the CAPE annually from 1871-2025 from Shiller’s personal webpage. To compute the payoff to market timing, I seemed on the annual returns to an non-market-timing investor who stayed with a 60% fairness/40% bond combine over time and in contrast it to the returns of a market timer, utilizing the brink/motion technique described above:
During the last century, this market timing technique would have lowered your annual returns 0.04% annually, and that’s earlier than transactions prices and taxes. When you break this up into two half-centuries, any of the market timing features had been from 1924-1974, they usually had been gentle, and attempting to time the market would have lowered your annual returns by 0.41% a yr, on common between 1975 and 2024.
To judge whether or not the payoff would have been completely different with alternate thresholds, we thought-about each a a lot decrease threshold (10%) and a a lot greater one (50%), with the previous resulting in extra market timing actions. We additionally checked out a extra aggressive response, the place the fairness portion was elevated to 100% (as a substitute of 80%) if the market was underpriced and lowered to 0% (as a substitute of 40%) if the market was overpriced. The outcomes are in beneath:
Conclusion
The choice on whether or not to time markets is a private one, and whereas I’ve concluded it doesn’t work for me, it might be presumptuous to say that it’ll not give you the results you want. When you resolve that market timing is a part of your funding philosophy, although, there are three classes that I hope that this submit has highlighted. The primary is that the extra incomplete your market timing metrics are, the better the possibility that you’ll chasing a correction that by no means occurs. It’s the purpose that you ought to be skeptical about arguments constructed round simply pricing, PE ratios or earnings yields (relative to treasury bond charges), and even with extra full metrics, you ought to be scanning the horizon for elementary modifications within the economic system and markets that will clarify the deviation. The second is that the proof {that a} metric will give you the results you want won’t come from statistical measures (correlations and regressions), however from creating and back-testing an actionable technique (of shopping for or promoting traded devices) based mostly on the metric. The third is that even if you happen to do all of this due diligence, market timing is noisy and flawed, and paraphrasing one other extensively used expressions, markets can keep mispriced for longer than you’ll be able to keep solvent.
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Datasets
- Historic returns on shares, bonds, payments, actual property and gold: 1927 – 2024
- PE, Normalized PE, Shiller PE and Earnings Yield Information for US Shares: 1960-2025
- Shiller knowledge on inventory returns, rates of interest and CAPE (month-to-month): 1871-2024 (from Shiller)
- Implied Fairness Threat Premiums for the S&P 500: 1960-2025
Spreadsheets
